Letter from Brussels: A simmering conflict

Conflict continues to simmer over the issue of passport rights for non-EU-domiciled hedge funds across the EU. On one side are global financial reformers while, on the other, are hedge funds, centred on the interests of the Cayman Islands. The two sides are currently engaged in a paper war.

A recent survey of the Madrid-based International Organization of Securities Commissions (IOSCO) calculates hedge fund assets of $2.6trn (€2.4trn) as at September 2014, up 34% over the two years since the previous study, although some of the increase might simply reflect more widespread reporting. The IOSCO survey notes that the Cayman Islands continue to be the “tax domicile of choice”.

IOSCO dwells on the third-country passporting issue and also the Alternative Investment Fund Managers Directive (AIFMD), which aims for EU harmonisation.

IOSCO notes that a member state may also allow funds domiciled outside the EU, but managed by an EU fund manager, to be marketed in that member state. However, that fund cannot be marketed across the EU.

PensionsEurope points to AIMA’s conclusion that few pension fund managers use the passport at present. Significantly, it adds that a large proportion would apply for a passport, were they to become available.

IOSCO is responsible to the Financial Stability Board (FSB) in Basel. The FSB also keeps an eye on the Paris-based European Securities and Markets Authority (ESMA), which reports to the European Commission.

ESMA has until June 2016 to deliver its formal guidance on second-level interpretations of AIFMD. Movement in Brussels is unlikely before this. On passport rights, ESMA has so far recommended in favour of Jersey, Guernsey and, conditionally, Switzerland. The Commission is said to wish to see the list expanded.

ESMA’s summaries of its position – via Q&A documents – show scant sympathy for the interests of the Cayman Islands. The latest summary deals with matters such as remuneration, and contractual arrangements, which are enough to cause dismay in the Caribbean territory.

ESMA has also issued notes on: the reporting of information on the changes in NAV per month; the distribution of dividends to investors; the conversion of total values into euros; a declaration of investment strategy; the mandatory nature of disclosure on information on liquidity; and, the calculation of assets under management.

An informed commentator talks of the removal of today’s “very light regulatory touch”. He says that “dark forces” in the hedge fund world do not want the passport regime to ever get off the ground because it might lead to the outlawing of the current alternative private placement regime.

Perhaps diplomatically, the Commission sidesteps crucial questions on the position of particular EU member states. This could be due to political sensitivity; the great majority of Europe’s 20% share of international hedge fund assets are managed from the UK.

At the European Parliament, Marcus Ferber, the centre-right German MEP, sums up the present impasse as “a regulatory gap”. In consequence, he recalls, both ESMA and the Commission have stated that they want to address this issue sooner rather than later.

But when is ‘sooner’? Well-funded lobbies have been known to hold up EU legislative initiatives not just for years but for decades. This battle looks like a collusion of giants, although the G20, FSB, IOSCO, European Commission and ESMA together represent a very tough adversary. Will this paper war end in bloodshed?